This week’s MoneyDo is to Review what you’re actually paying for your annuity.

Many annuities are complex financial instruments accompanied by complex paperwork detailing how they work and the spider web of fees associated with them.

And it’s not because you’re dumb. Craig McCann, a former economist for the Securities and Exchange Commission, built a computer model intended to calculate if an annuity is right for someone. He employed a dozen people with Ph.D.s in math to “dissect indexed annuity products.” He said it took years for his team to master them[i].

Though it appears that investors have some exposure to the stock market, he says many are left with a return they could have achieved with a supersafe bond portfolio, without paying an obscured 2.5 to 3 percent annual fee charged by the annuity provider. “They are all Rube Goldberg machines,” he said[ii].

If you own an annuity, seek how much you’re paying on fees. It’s important to understand that these fees aren’t always broken out clearly, and you might have to read deep into the fine print in order to get all the information you need on the annuity fees you’re paying, like[iii]:

1. Administration and contract maintenance charges

Insurance companies have overhead costs that they need to offset in order to offer annuities. Some annuities therefore include a specifically listed charge to maintain the policy, covering both the administrative costs of things like preparing regular statements and the ongoing expenses of monitoring the annuity contract.

2. Surrender charges

Sometimes you’ll see the term “contingent deferred sales charges” instead. Many annuity companies charge you a fee if you decide to back out of an annuity contract within a set period of time. The length of the surrender-fee period can differ, with some companies charging surrender fees for seven to 10 years. Often, the surrender fee will go down over time, with the highest charge applying if you cancel your annuity very soon after purchasing it. Some annuities offer exemptions or partial withdrawals without a surrender fee, but with typical surrender charges amounting to several percent of the contract value, you need to be absolutely sure you understand the long-term nature of many annuities before you buy one.

3. Mortality and expense risk fees

Perhaps the most confusing annuity fee is the mortality and expense risk charge. The M&E expense fees compensate the insurance company for taking on the risk that it will get its estimates of essential factors like life expectancy and its underlying overhead expenses wrong and therefore end up having to pay some of those costs out of its own profits.

Yet this fee is often large enough to cover other expenses as well, such as sales and marketing fees, and generate profit for the insurance company as well. You may find commissions included in this fee. (More on that later).

In fact, these fees are often the key reason why annuity fees are higher than those for mutual funds with similar investments. Annuities do have some features that mutual funds don’t, but many annuity owners never end up taking advantage of all of them, making it questionable whether they’re getting their money’s worth for the extra money they’re spending.

4. Premium taxes

Many states charge taxes on insurance products. In turn, some insurance companies pass through those taxes to buyers of those products, including annuities.

5. Underlying investment expenses

Annuities often invest in pooled investments like mutual funds. Mutual funds do have expenses of their own, which annuity sellers will pass on to its policyholders. Specifically, annuity owners can end up paying added expenses for mutual fund management as well as marketing and distribution fees that the fund company incurs.

Some underlying funds also charge short-term trading fees for shifting in and out of the fund on a frequent basis, and annuity companies can pass those costs on to investors as well. Like the mortality and expense risk fee, underlying investment fees are expressed as a percentage of the amount you have invested, and they’re charged on an annual basis, representing an ongoing drain on your investment capital.

6. Rider fees

Many annuities offer additional optional features, which are sometimes called riders. These add-ons can give you attractive benefits, such as guarantees of minimum levels of income or death benefits. Typically, though, you’ll have to pay an extra fee in order to take advantage of these optional guarantees.

Riders also change and limit what you are invested in. Today most buyers who opt for a rider — 88% do, says research firm LIMRA — will see their stock stake capped at around 60%. You may also be required to use model portfolios or “managed-volatility” funds, which automatically shift assets from stocks to more conservative choices if your account value falls a certain percentage within a short time[iv].

7. Commissions

When you buy an annuity through a broker you will pay a commission, which can range from 1% to 10% depending on the product (the longer the surrender period, the higher the commission).